How one company negotiated $100,000 in capital in exchange for royalties based on sales.
You need money to fuel your company's growth, but the idea of selling equity too soon leaves you cold. For starters, investors usually want a major stake in a business in the early stages. And loans, while usually more palatable, are tough for a young company to get. Recently, however, Andover Advanced Technologies, a two-year-old sales-and-marketing company, grabbed hold of a third option. In exchange for $100,000 in capital, the Westford, Mass., company agreed to pay investors a royalty based on sales. If its products do well, investors will earn handsome returns; if the products fizzle, the investors may lose their entire investment, but the company is protected.
Royalty deals, though rare, seem to be on the rise as both companies and investors become aware of their assorted virtues. For companies, the royalty arrangement postpones the whole question of valuation and allows a business to distribute cash on the basis of actual sales; it also keeps decisions about the future in the hands of management (since royalty investors typically don't have seats on boards).
Investors, meanwhile, don't have to worry about whether the management can build a successful company with the staying power to pull off an initial public offering four or five years from now; they can make their decision based on the near-term prospects of products they can see for themselves.
"With royalty deals, there's lots of flexibility," explains William Contente, a partner with Lucash, Gesmer & Updegrove, in Boston. "The structure can be quite simple." In the case of Andover Advanced (which sells software products to distributors), the company pledged to pay investors between 8% and 12% of net product sales each month. How long the payments will be made is contingent on sales. If things go well, the company gets to stop making payments when it hits one of two caps: (1) if investors receive three times their initial investment in the first year or (2) if they get a total of five times their money back anytime after that. Clearly, president Bruce Twickler admits, this type of money can be expensive. But compared with the other available options, he notes, it was easy to embrace. "If we're successful, we may not need any additional money," he says. "And if we do, we think we'll sell stock at a price that's quite a bit higher than anything we could have obtained last fall."
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Although royalty financing is gaining popularity, it isn't easy to find investors who are familiar with how to structure such deals. Here are two groups with experience in that area: Royalty Capital Fund, in Lexington, Mass., 617-861-8490, which is raising capital to invest in royalty transactions; and First Principal Royalty, in Mount Carmel, Ill., 618-263-3796, which advises businesses on royalty arrangements.